International Business: The Challenges of

Globalization
Ninth Edition

Chapter 5
International Trade Theory

Copyright © 2019 Pearson Education, Inc.

Learning Objectives
5.1 Describe the benefits, volume, and patterns of international
trade.
5.2 Explain how mercantilism worked and identify its inherent
flaws.
5.3 Detail the theories of absolute advantage and comparative
advantage.
5.4 Summarize the factor proportions theory of trade.
5.5 Explain the international product life cycle theory.
5.6 Outline the new trade theory and the first-mover advantage.
5.7 Describe the national competitive advantage theory and the
Porter diamond.
Copyright © 2019 Pearson Education, Inc.
From Bentonville to Beijing
• In 1991 Walmart first became an
international company.
• Ambitious global expansion:
– Walmart has around 5,300 stores in
the United States and more than
6,200 stores in 27 other countries.
– Nearly $486 billion in sales globally.
– Walmart is one of the world’s largest
companies.
– Walmart sources inexpensive
merchandise from low-cost
production locations such as China.
• Helping boost international trade.

Copyright © 2019 Pearson Education, Inc.

Benefits, Volume, and Patterns of
International Trade (1 of 4)
• International Trade: Purchase, sale, or exchange of goods
and services across national borders
• Benefits of International Trade:
– Greater choice of goods and services
– Important engine for job creation in many countries

• International trade provides a country’s people with a greater

choice of goods and services.
• International trade is also an important engine for job creation in
many countries. The U.S. Department of Commerce
(www.commerce.gov) calculates that for every $1 billion
increase in exports, 22,800 jobs are created in the United
States.
Copyright © 2019 Pearson Education, Inc.
Benefits, Volume, and Patterns of
International Trade (2 of 4)
Volume of International Trade
Table 5.1 World’s Top Exporters
World’s Top Merchandise Exporters World’s Top Service Exporters
Value Share of Value Share of
(U.S. $ World (U.S. $ World
Rank Exporter billions) Total (%) Rank Exporter billions) Total (%)
1 China 2,275 13.8 1 United States 690 14.5
2 United States 1,505 9.1 2 United Kingdom 345 7.3
3 Germany 1,329 8.1 3 China 285 6.0
4 Japan 625 3.8 4 Germany 247 5.2
5 Netherlands 567 3.4 5 France 240 5.0
6 South Korea 527 3.2 6 Netherlands 178 3.7
7 Hong Kong 511 3.1 7 Japan 158 3.3
8 France 506 3.1 8 India 155 3.3
United 9 Singapore 139 2.9
9 Kingdom 460 2.8
10 Ireland 128 2.7
10 Italy 459 2.8
Source: Based on International Trade Statistics 2013 (Geneva: World Trade Organization, November 2013),
Tables I.7 and I.9, available at www.wto.org.
Copyright © 2019 Pearson Education, Inc.
Benefits, Volume, and Patterns of
International Trade (4 of 4)
Trade Interdependence
• Trade among most nations is characterized by a degree
of interdependency.
• Trade dependency has been a blessing for many Central
and Eastern European nations.
• The dangers of trade dependency become apparent
when a nation experiences economic recession or
political turmoil.

Copyright © 2019 Pearson Education, Inc.

Quick Study 1
1. List several benefits of international trade.
2. World merchandise exports are valued at how many
times the value of worldwide service exports?
3. What portion of total world merchandise trade is
accounted for by two-way trade between high-income
economies?
4. What term often describes the nature of trade between
a developing nation and a neighboring wealthy one?

Copyright © 2019 Pearson Education, Inc.

Mercantilism (1 of 3)
Figure 5.1 Trade Theory Timeline

Copyright © 2019 Pearson Education, Inc.

Mercantilism (2 of 3)
How Mercantilism Worked
• Mercantilism: Trade theory that nations should accumulate
financial wealth, usually in the form of gold, by encouraging
exports and discouraging imports
Three Pillars
• Maintain Trade Surplus
• Government Intervention
• Colonialism

Copyright © 2019 Pearson Education, Inc.

Mercantilism (3 of 3)
Flaws of Mercantilism
• World trade is a zero-sum game.
• Restricts international trade
• Limits colonies’ market potential

Copyright © 2019 Pearson Education, Inc.

Quick Study 2
1. What did the successful implementation of mercantilism
require?
2. Mercantilist nations acquired colonies around the world to
serve as sources of what?
3. What name is given to the belief that a nation can
increase its wealth only at the expense of other nations?

Copyright © 2019 Pearson Education, Inc.

Theories of Absolute and Comparative
Advantage (1 of 5)
• Absolute Advantage: Ability of a nation to produce a good
more efficiently than any other nation

Blank Units Required for Production Units Required for Production

Rice Tea

Riceland 1 5
Tealand 6 3

Another way of stating each nation’s efficiency in the production

of rice and tea is:
1
• In Riceland, 1 unit of resources = 1 ton of rice or ton of tea
5
• In Tealand, 1 unit of resources = 1 ton of rice or 1 ton of tea
6 3
Copyright © 2019 Pearson Education, Inc.
Theories of Absolute and Comparative
Advantage (2 of 5)
Specialization and trade: Figure 5.2 Gains from Specialization
and Trade: Absolute Advantage
+ Riceland gets five times
more tea than it would
have produced itself.
+ Tealand gets two times
more rice than it would
have produced itself.

Copyright © 2019 Pearson Education, Inc.

Theories of Absolute and Comparative
Advantage (3 of 5)
• Comparative Advantage: Inability of a nation to produce a
good more efficiently than other nations but an ability to produce
that good more efficiently than it does any other good
Blank Units Required for Production Units Required for Production
Rice Tea
Riceland 1 2
Tealand 6 3

Another way of stating each nation’s efficiency in the production

of rice and tea is:
1
• In Riceland, 1 unit of resources = 1 ton of rice or ton of tea
2
1 1
• In Tealand, 1 unit of resources = ton of rice or ton of tea
6 3
Copyright © 2019 Pearson Education, Inc.
Theories of Absolute and Comparative
Advantage (4 of 5)
Specialization and trade: Figure 5.3 Gains from Specialization
and Trade: Comparative Advantage
+ Riceland gets two times
more tea than it would
have produced itself.
+ Tealand gets two times
more rice than it would
have produced itself.

Copyright © 2019 Pearson Education, Inc.

Theories of Absolute and Comparative
Advantage (5 of 5)
Assumptions and Limitations
• Nations strive only to maximize production and
consumption.
• Only two countries produce and consume just two goods.
• No transportation costs of traded goods.
• Labor is the only resource used to produce goods and it
cannot cross borders.
• Specialization does not create efficiency and improvement
gains.

Copyright © 2019 Pearson Education, Inc.

Quick Study 3
• A nation that is able to produce a good more efficiently
than other nations is said to have what?
• What does a nation have when it is unable to produce a
good more efficiently than other nations but it can produce
the good more efficiently than it can any other good?
• The theories of absolute advantage and comparative
advantage say that nations benefit from trading because
of the gains from what?

Copyright © 2019 Pearson Education, Inc.

Factor Proportions Theory (1 of 2)
• Factor Proportions Theory: Trade theory stating that
countries produce and export goods that require resources
(factors) that are abundant and import goods that require
resources in short supply

Copyright © 2019 Pearson Education, Inc.

Factor Proportions Theory (2 of 2)
The Leontief Paradox
• The Apparent Paradox
– Leontief found evidence opposite of that predicted by the factor
proportions theory.
 U.S. exports require more labor-intensive production than
U.S. imports.
 Leontief’s findings are supported by more-recent research.
– Paradox between the predictions using the factor proportions
theory and the actual trade flows
• What might account for the paradox?
– Factor proportions theory assumes nation’s production factors
to be homogeneous.
– Factor proportions theory seems to be supported when
expenditures on labor are taken into account.
Copyright © 2019 Pearson Education, Inc.
Quick Study 4
1. What is the name of the theory that says countries
produce and export goods that require resources that
are abundant and import goods that require resources
in short supply?
2. Factor proportions theory divides a nation’s resources
into what two categories?

Copyright © 2019 Pearson Education, Inc.

International Product Life Cycle (1 of 2)
Stages of the Product Life Cycle
• International Product Life Cycle: Theory stating that a company
will begin by exporting its product and later undertake foreign
direct investment as the product moves through its life cycle
Figure 5.4 International Product Life Cycle

Copyright © 2019 Pearson Education, Inc.

International Product Life Cycle (2 of 2)
• Vernon developed his model around the United States.
• The theory’s ability to accurately depict the trade flows
of nations is weak.
• The United States is no longer the sole innovator of
products in the world.
• Today, there is quicker product obsolescence.
• Older theories might better explain today’s global trade
patterns.

Copyright © 2019 Pearson Education, Inc.

Quick Study 5
1. The international product life cycle theory says that a
company will begin by exporting its product and later
undertake what as the product moves through its life
cycle?
2. List the three stages that a product goes through
according to the international product life cycle theory.
3. Whenever optimizing productivity determines where a
product’s components are manufactured and where it is
assembled, the resulting pattern of activities resembles
that predicted by which theory?

Copyright © 2019 Pearson Education, Inc.

New Trade Theory
Fundamentals
• Gains from specialization
and increasing economies
of scale
• Barriers to entry
• Role of government
First-Mover Advantage
• Economic and strategic
advantage
• Formidable barrier to market
entry for potential rivals
• Country’s export and home-
based firm
Copyright © 2019 Pearson Education, Inc.
Quick Study 6
1. What is the main thrust of the new trade theory?
2. The economic and strategic advantage gained by being
the first company to enter an industry is called what?

Copyright © 2019 Pearson Education, Inc.

National Competitive Advantage
1. Factor Conditions
• Basic Factors
• Advanced Factors

2. Demand Conditions
• Sophisticated Buyers

3. Related and Supporting Industries

• Clusters

4. Firm Strategy, Structure, and Rivalry

• Competitiveness

Government and Chance

• Role of Government
• Chance Events

Copyright © 2019 Pearson Education, Inc.

• Michael Porter put forth a theory in 1990 to explain why certain countries are leaders in
the production of certain products. His national competitive advantage theory states
that a nation’s competitiveness in an industry depends on the capacity of the industry to
innovate and upgrade.

• Michael Porter identifies four elements that are present to varying degrees in every nation
and that form the basis of national competitiveness. The Porter diamond consists of (1)
factor conditions, (2) demand conditions, (3) related and supporting industries, and (4)
firm strategy, structure, and rivalry.
• Factor Conditions: Porter acknowledges the value of a nation’s resources, which
he terms basic factors, but he also discusses the significance of what he calls
advanced factors. Advanced factors include the skill levels of different segments of
the workforce and the quality of the technological infrastructure in a nation.
• Demand Conditions: Sophisticated buyers in the home market are also important
to national competitive advantage in a product area. A sophisticated domestic
market drives companies to add new design features to products and to develop
entirely new products and technologies.
• Related and Supporting Industries: Supporting industries spring up to provide the
inputs required by the industry.
• Firm Strategy, Structure, and Rivalry: Essential to successful companies is the
industry structure and rivalry between a nation’s companies. The more intense the
struggle to survive between a nation’s domestic companies, the greater will be their
competitiveness. Copyright © 2019 Pearson Education, Inc.
• Government and Chance: Apart from the four factors identified as part of the diamond,
Porter identifies the roles of government and chance in fostering the national
competitiveness of industries. First, governments, by their actions, can often increase
the competitiveness of firms and perhaps even entire industries. Second, although
chance events can help the competitiveness of a firm or an industry, it can also threaten
it.

Copyright © 2019 Pearson Education, Inc.

Quick Study 7
1. The national competitive advantage theory states that a
nation’s competitiveness in an industry depends on the
capacity of the industry to do what?
2. The four main components of the Porter diamond are: (1)
factor conditions, (2) demand conditions, (3) firm strategy,
structure, and rivalry, and what else?
3. A group of related industries that spring up in a geographic
area to support a nation’s competitive industry is called a
what?

Copyright © 2019 Pearson Education, Inc.

Copyright

Copyright © 2019 Pearson Education, Inc.